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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
demands for collateral based on marks that were initially well below those of other
firms—while AIG and its management struggled to come to grips with the burgeoning
crisis.
The initial collateral call was a shock to AIG’s senior executives, most of whom
had not even known that the credit default swaps with Goldman contained collateral
call provisions.
They had known there were enormous exposures— billion, backed in large
part by subprime and Alt-A loans, in , compared with the parent company’s to-
tal reported capital of . billion—but executives said they had never been con-
cerned. “The mantra at [AIG Financial Products] had always been (in my
experience) that there could never be losses,” Vice President of Accounting Policy
Joseph St. Denis said.
Then came that first collateral call. St. Denis told FCIC staff that he was so
“stunned” when he got the news that he “had to sit down.” The collateral provisions
surprised even Gene Park, the executive who had insisted months earlier that AIG
stop writing the swaps. He told the FCIC that “rule Number at AIG FP” was to
never post collateral. This was particularly important in the credit default swap busi-
ness, he said, because it was the only unhedged business that AIG ran.
But Jake Sun, the general counsel of the Financial Products subsidiary, who re-
viewed the swap contracts before they were executed, told the FCIC that the provi-
sions were standard both at AIG and in the industry. Frost, who was the first to
learn of the collateral call, agreed and said that other financial institutions also com-
monly did deals with collateral posting provisions. Pierre Micottis, the Paris-based
head of the AIG Financial Products’ Enterprise Risk Management department, told
the FCIC that collateral provisions were indeed common in derivatives contracts—
but surprising in the super-senior CDS contracts, which were considered safe. In-
surance supervisors did not permit regulated insurance companies like MBIA and
Ambac to pay out except when the insured entity suffered an actual loss, and there-
fore those companies were forbidden to post collateral for a decline in market value
or unrealized losses. Because AIG Financial Products was not regulated as an insur-
ance company, it was not subject to this prohibition.
As disturbing as the senior AIG executives’ surprise at the collateral provisions
was their firm’s inability to assess the validity of Goldman’s numbers. AIG Financial
Products did not have its own model or otherwise try to value the CDO portfolio
that it guaranteed through credit default swaps, nor did it hedge its exposure. Gene
Park explained that hedging was seen as unnecessary in part because of the mistaken
belief that AIG would have to pay counterparties only if holders of the super-senior
tranches incurred actual losses. He also said that purchasing a hedge from UBS, the
Swiss bank, was considered, but that Andrew Forster, the head of credit trading at
AIG Financial Products, rejected the idea because it would cost more than the fees
that AIG Financial Products was receiving to write the CDS protection. “We’re not
going to pay a dime for this,” Forster told Park.
Therefore, AIG Financial Products relied on an actuarial model that did not pro-
vide a tool for monitoring the CDOs’ market value. The model was developed by
